BioCycle July 2008, Vol. 49, No. 7, p. 46
BIOMASS economics relies on the basic laws of supply and demand. When there is an abundance of a material, such as solid waste or manure, the price is low or negative. If the feedstock is scarce like food-grade vegetable oil, the price is really high. There are many complex nuances on this economic frontier, but supply and demand still shape the debate.
This is certainly happening with essentially all forms of biomass. As more biomass heating projects come on-line – fueled by wood chips, sawdust and fuel pellets – biomass is becoming less abundant and in greater demand, even for nonenergy uses.
The demand for green power and fuel pellets is so great in Europe that hundreds of thousands of tons of U.S. grown biomass are heading there. In June, the Green Circle Bio Energy pellet fuel plant in Cottondale, Florida opened and will produce 500,000 tons of pellet fuel destined for the European solid fuel markets. This is basic supply and demand.
Until recently, traditional supply and demand economics have, for the most part, also governed pricing for commodities like corn and crude oil. Yet, the current food vs. fuel debate is a reflection of the gaps in our understanding of the supply and demand of corn and energy as well as environmental benefits. There is agreement that feed, fuel and food demands for corn are strong and the price keeps going up. The debate is about what is driving the price up.
The Midwest floods in June have added to the corn supply pressures. Key corn growing states lost millions of crop acres to floods. The only certainty about the 2008 crop is that fewer corn acres will be harvested than were intended. When the supply is challenged the price jumps radically. In just a few weeks of reported heavy rains and flooding, the price of corn jumped about 20 percent to $7.30/bushel – though the crop losses appear to be proportionately less than the price increase.
Crude oil prices are struggling with supply and demand issues also. Energy analysts keep thinking in terms of supply and demand solutions. There is intense pressure to expand production. However, the components of supply and demand that are out of balance are not enough to justify the amazing pace of price increases.
BEYOND SUPPLY AND DEMAND
If traditional supply and demand analyses aren’t sufficient to explain the wild ride with fuel and corn prices, what is? Increasingly, the case is being made that much of the commodity price inflation is being driven by speculative investors bidding up the price of food and energy. Indeed the Commodity Futures Trading Commission (CFTC) is investigating this possibility.
Cash markets can be very volatile. News of natural disasters, shifts in government policy and other daily events can cause radical shifts in the market price. Cash markets are in real time. They define the transaction.
For commonly traded commodities, it is possible to lock in a price in the future by buying a contract for delivery at a certain date. These are called futures contracts. They are invaluable in managing market risks. Buying a futures contract today for delivery several months into the future is referred to as a “hedge.” This allows those with money to lose in the market to fix their price regardless of the daily market swings. Traditionally, futures contracts have less price volatility than cash markets because buyers and sellers are guessing about the future value.
This is in contrast to “speculators,” who are using futures contracts to manage their investment risk and do not own any real goods. Speculators are using commodity futures contracts like stock investments. The very act of doing this creates an imaginary demand and raises the price artificially.
The CFTC already regulates the futures market. There are rules. What is unknown today is if the rules are sufficient. The current CFTC review of futures contract regulation has generated a parade of industry and government experts through multiple Congressional hearings. Testimony at these hearings acknowledges the existence of speculators, but explanations and assessments of their exact impact go from one extreme to the other.
Michael Masters, Masters Capital Management, testified before the US Senate Committee on Homeland Security and Governmental Affairs on May 20, 2008. He presented some very compelling data on what he calls Index Speculators. He claims speculators have bid up and essentially stockpiled contracts on the imaginary equivalent of over a billion barrels of petroleum and 1.3 billion bushels of wheat. As the artificial demand for the futures commodities go up, so does the price. Then more speculators buy more futures, and prices go even higher for the industries that actually use the commodities.
On June 24, 2008, Walter Lukken, Acting Chairman of the CFTC, testified to the full Committee on Agriculture, House of Representatives that the CFTC was on top of the issue. The Chairman outlined five broad initiatives: 1) Increase transparency; 2) Ensure proper market controls; 3) Continue enforcement; 4) Improve oversight and 5) Seek more funding. So basically, they are still working on it.
Rising energy prices are influencing everything from gasoline to compost feedstocks. There are many legitimate factors that have caused energy prices to rise. Economic supply and demand play a significant role, but something more, like the influence of speculative commodity trading, is fueling the explosive price increases in agricultural, organics and energy commodities.
Mark Jenner, PhD, operates Biomass Rules, LLC and has over 25 years of biomass utilization expertise. Burning Bio News is Jenner’s monthly scorecard of bioenergy project adoption, available at www.biomassrules.com.